Some investors stretching for income in recent years have been attracted to real estate investment trusts that specialize in mortgages. However, ETFs tracking mortgage REITs are down sharply the past few months with the Federal Reserve signaling it may taper its bond purchases.
For example, iShares Mortgage Real Estate Capped ETF (NYSEArca: REM) and Market Vectors Mortgage REIT Income ETF (NYSEArca: MORT) are both down more than 20% from their 52-week highs.
The recent “nosedive” in REM was driven by “instability in the yield curve and falling book values,” says Morningstar ETF analyst Abby Woodham.
“For investors considering an allocation to REM, the sharp decline of mortgage REITs over recent months should serve as a reminder of this asset’s high risk profile,” she wrote in an article posted Wednesday. “Mortgage REITs’ double-digit yield, while attractive, is a flashing signal that this subsector is only appropriate for very risk-tolerant investors willing to make a bet on future rates. On the upside, mortgage REIT valuation is fast approaching post-2008 discount levels.”
REM has a 30-day SEC yield 13.77%, according to BlackRock. [Mortgage REIT ETFs Hit as Interest Rates Surge]
REM and MORT have been selling off as Treasury yields spike.
“Mortgage REITs are very susceptible to the risk of rising short-term rates. Until recently, mortgage REITs have benefited from the Fed’s easy money policy. The Fed’s historically low near-zero interest rate makes financing cheap, allowing mortgage REITs to use leverage to provide an attractive yield. However, because these firms are so extensively leveraged, they are very susceptible to interest-rate fluctuations,” Woodham notes.
“Even the whisper of changing rates can send the market into a panic, as seen over the past three months,” she added.
iShares Mortgage Real Estate Capped ETF
Full disclosure: Tom Lydon’s clients own REM.